Price Optimization: The Science-Like Art of Finding the Sweet Spot
Figuring out how to price your goods or services is a bit like fumbling in the dark. You may eventually find what you’re looking for, but no one likes blindly fumbling around as they stumble and flail in the dark. And price optimization, without data, can be a similarly frustrating process.
Many companies will set their prices based on what their competitors are charging--which could be right on the money. But for most businesses, this approach isn't ideal. An effective price optimization strategy should take into account your company's costs, operating revenue, and business goals.
There isn't any magical solution to help you find the optimal price point. Pricing strategy takes time and research. Tools like SPARXiQ can make the process easier. This pricing optimization software can effortlessly analyze all of your sales and customer information--customer segments, historical data, price points, and market data--to offer astute price recommendations based on product or service and customer segment.
Let's take a look at some best practices for price optimization, including what you should be optimizing for with your pricing strategies and some common mistakes to steer clear of.
We'll cover some basic terms and concepts related to price optimization, too.
After reading this article, you should have a good understanding of how pricing optimization works, various pricing strategies to consider, and how smart pricing--which sometimes means higher pricing--can improve customer satisfaction.
Simply put, price optimization means the process of finding the right price for a product or service. The process takes into account costs, competition, customer willingness to pay, and ultimate perceived value to customers.
Price elasticity of demand is a measure of whether customers are willing to buy a given good or service when the price changes.
Typically, we may think of price demand as elastic. When something goes up in price, customers' willingness to pay goes down.
But that’s not always the case. Some goods are inelastic, like prescription drugs, baby formula, gasoline, a jug of milk, and other necessity goods.
Price elasticity is an important concept for any business to grasp. If your business has a product with inelastic demand, you can adjust (raise) pricing and maintain the majority of your customer base. But with elastic goods and services, however, you may want to keep your prices low to maximize sales.
There are three things to optimize your pricing for.
If you're priced too high, the customer may not buy the product because they can't afford to or they're seeking more inexpensive options.
If you're priced too low, your company may not be maximizing its profit--or turning any profit at all. And, you may lose potential customers who perceive your goods or services to be of lower quality based on your pricing.
When you optimize your pricing, it's not just one set price you're considering. You're looking at your starting price, and then any discounts or promotions you want to offer to attract customers and be competitive.
Even the most high-end of prestige brands will occasionally lower prices or run promotions. While they may shy away from BOGOs or price tags ending in $0.99--techniques that could dilute their brand--there are other tactics they may employ, like free gifts with purchase, reduced cost gifts with purchase, free concierge services, and free shipping.
Bargain-hungry customers want deals. Offer too many discounts, you train customers to expect (demand) them all of the time. Additionally, freebie-seeking customers are not brand-loyal and will turn on your brand in an instant. But by not offering any discounts, you're leaving money on the table--and customers at the door.
Getting the mix right--for starting, discount, and promotional pricing--is a delicate balancing act. Dynamic pricing solutions--blending customer data, consumer behavior, and competitors' prices--can help you strike the right balance.
Pricing optimization software can take these myriad inputs and offer you data-based recommendations to guide pricing, like pricing tiers or pricing rules by customer segmentation.
Here are some common reasons why your price optimization strategy may fall short.
With data that is outdated or inaccurate, you will set your prices too high or too low or not understand current market trends and consumer preferences. The current, accurate data you need should come from your sales figures, market research reports, competitor intelligence, and industry publications. Market research firms, price optimization software, and statistical software can analyze the data for trends and patterns, including enhanced data visualization.
Many business leaders pride themselves on having that "gut feeling" they can rely on for making major business decisions. And it may be that some people do have those magic, crystal-ball instincts.
But in general, operating off crystal-ball instincts or gut feelings is unreliable. Hunches require luck and are influenced by personal bias, which can lead to some truly epically bad outcomes.
Another problem with hunches is that the loudest voice or most senior title in the boardroom wins, and may make decisions not grounded in reality (data).
Using data to make informed decisions removes both politics and hunches from the agenda, and provides a neutral framework from which to work.
Using too many discounts can be a big reason why your price optimization solutions aren't working.
When you overdo it with markdowns, you devalue your business' products and services. You train your consumers to expect a discount, or switch to a competitor offering price reductions. This can also lead to people viewing your goods and services as less valuable or premium.
Excessive discounts can also cannibalize your regular sales, leading customers to pay a reduced price for your goods when they would have been otherwise willing to pay full price.
Finally, too many discounts will make it extremely difficult for you to raise prices in the future. Even if customers value your brand, you've trained them not to pay full price. You're that company that always has a promo code.
Offering discounts can be an important component of your overall price optimization, but make sure to deploy them strategically.
Your pricing strategy may fail or be less-than-effective if you're not pricing your services or goods for the value you're delivering to customers.
Ask yourself these questions:
As we've stated before, you can't set prices too high or too low. Price high enough so you're making a profit and/or positioning yourself as high-quality, but not so high you're scaring away customers.
This is why understanding the value you deliver--and customer perception of that value--is so key. It's not simply a matter of taking landed costs x 2.5 to reach your selling price.
Take prescription eyeglasses, for example. Glasses--with first-quality lenses and designer frames--cost anywhere from $6.50 to $18 to make but sell at a 1,000% markup--or more.
Customers are willing to pay more because of the impact prescription glasses have on their life, and they're accustomed to a higher price tag. Customers are so well-trained, in fact, they would likely distrust a $15 price tag at the optical store
Even Warby Parker, known for disrupting the market with its ultra-cheap eyewear, sells Rx glasses from $95--which is still around an 800% markup.
Even if you sell primarily to the U.S. market, the geographical expanse of the country is huge. The cost of living varies significantly by region throughout the U.S. Even within the same metro areas, many retailers will price goods differently based on micro-market conditions. Some suburbs or portions of suburbs may have different residential and economic characteristics.
Additionally, customer expectations and business competition can vary by location.
Using geography-based pricing--or micro-pricing--will help you optimize pricing and maximize profits. And you'll also maintain customer satisfaction by meeting their specific expectations of their well-defined market segments.
While regular data and analysis are crucial to any business pricing strategy, it can fail if your process is too complex. Just because your pricing strategy could have 50 different tiers–based on myriad ways to slice and dice the data–doesn't mean that it should.
Too much complexity is:
Pricing can be complex, but it doesn't have to be painful.
Price optimization is the process of setting prices for products or services in a way that maximizes profits. It is a complex process that involves a number of factors, including:
There are many price optimization models that businesses can use to set prices. Some of the more common models of price management and optimization include the following:
These are just a handful of price optimization examples. There are other ways to set or adjust pricing, and many pricing strategies can be a hybrid approach.
The best pricing process for your business depends on many factors, including your industry, product or services sold, your target market, and pricing data from your competitors.
There are a number of tools and inputs that can be used to optimize pricing. Some of the most common ones include:
As touched on in our previous section about price optimization tools, price optimization software can greatly automate the process for you.
While you'll still need to gather customer, sales, and competitor data--and know your business targets--price optimization software can use these inputs to recommend the best price or prices for your goods and services.
The process is still arduous and painstaking because it’s crucial to get it right, but software can help you automate large chunks of the process with expert analysis and actionable data visualization.
When evaluating the right software solution for your business, there are a few things to keep in mind.
As you evaluate different options, other factors should be considered too.
Setting prices for your business products or services can be a complex process, but gathering and analyzing the right data can help you avoid missteps. Pricing too high or too low could mean lost customers and lost sales, but a good price optimization process takes into account production and distribution costs, changing customer demand, competitor pricing, business goals, and the "going" market price that customers are willing (or trained) to pay.
Continually gathering and analyzing data and keeping a flexible approach can help you optimize pricing to meet the expectations of new and existing customers and business stakeholders.
